State National Companies 10-Q 2017 Q3 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)
☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2017

Or

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from		to
Commission File Number	001-36712

STATE NATIONAL COMPANIES, INC.

(Exact name of registrant as specified in its charter)

Delaware	26-0017421
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
1900 L. Don Dodson Drive, Bedford, Texas	76021
(Address of principal executive offices)	(Zip Code)

(817) 265-2000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒  No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ☒  No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” ��smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  ☐	Accelerated filer  ☒
Non-accelerated filer  ☐ (Do not check if a smaller reporting company)	Smaller reporting company  ☐
	Emerging growth company  ☒

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes ☐ No ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class	Outstanding at November 08, 2017
(Common stock, $.001 par value)	42,173,561 Shares

STATE NATIONAL COMPANIES, INC.

INDEX

		Page No.
Part I - Financial Information
Item 1	Unaudited Condensed Consolidated Financial Statements
	Condensed Consolidated Balance Sheets – September 30, 2017 (unaudited) and December 31, 2016	1
	Unaudited Condensed Consolidated Statements of Income – nine months ended September 30, 2017 and 2016	3
	Unaudited Condensed Consolidated Statements of Comprehensive Income – nine months ended September 30, 2017 and 2016	4
	Unaudited Condensed Consolidated Statements of Shareholders’ Equity – nine months ended September 30, 2017 and twelve months ended December 31, 2016	5
	Unaudited Condensed Consolidated Statements of Cash Flows – nine months ended September 30, 2017 and 2016	6
	Notes to Unaudited Condensed Consolidated Financial Statements	7
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22
Item 3	Quantitative and Qualitative Disclosures About Market Risk	36
Item 4	Controls and Procedures	38
Part II - Other Information
Item 1	Legal Proceedings	39
Item 1A	Risk Factors	39
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	40
Item 3	Defaults Upon Senior Securities	40
Item 4	Mine Safety Disclosures	40
Item 5	Other Information	40
Item 6	Exhibits	40

PART I - FINANCIAL INFORMATION

Item 1:  Unaudited Condensed Consolidated Financial Statements

STATE NATIONAL COMPANIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

($ in thousands)

	September 30,		December 31,
	2017		2016
		(Unaudited)
Assets
Investments:
Fixed-maturity securities – available-for-sale, at fair value (amortized cost – $400,885, $329,994, respectively)	$	406,677	$	332,107
Equity securities – available-for-sale, at fair value (cost – $2,039, $3,271, respectively)		2,116		3,224
Total investments		408,793		335,331
Cash and cash equivalents		64,003		91,698
Restricted cash and investments		25,192		2,958
Accounts receivable from agents, net		145,867		35,964
Reinsurance recoverable on paid losses		1,740		1,430
Deferred acquisition costs		1,348		1,194
Reinsurance recoverables		2,871,500		2,342,864
Property and equipment, net (includes land held for sale – $1,034, $1,034, respectively)		16,999		16,163
Interest receivable		2,319		2,112
Income taxes receivable		—		329
Deferred income taxes, net		30,900		28,858
Goodwill and intangible assets, net		14,364		12,588
Other assets		7,680		5,248
Total assets	$	3,590,705	$	2,876,737

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

1

STATE NATIONAL COMPANIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (continued)

($ in thousands, except for share and per share information)

	September 30,		December 31,
	2017		2016
		(Unaudited)
Liabilities
Unpaid losses and loss adjustment expenses	$	2,087,941	$	1,703,706
Unearned premiums		828,583		680,691
Allowance for policy cancellations		68,568		66,418
Deferred ceding fees		39,639		32,226
Accounts payable to agents		2,467		2,639
Accounts payable to insurance companies		118,791		14,871
Debt, net		43,815		43,783
Income taxes payable		3,649		—
Other liabilities		63,454		36,023
Total liabilities		3,256,907		2,580,357
Shareholders’ equity
Common stock, $.001 par value (150,000,000 shares authorized; 42,173,561 and 41,924,440 shares issued at September 30, 2017 and December 31, 2016, respectively)		42		42
Preferred stock, $.001 par value (10,000,000 shares authorized; no shares issued and outstanding at September 30, 2017 and December 31, 2016)		—		—
Additional paid-in capital		232,710		229,297
Retained earnings		98,073		66,230
Accumulated other comprehensive income		2,973		811
Total shareholders’ equity		333,798		296,380
Total liabilities and shareholders’ equity	$	3,590,705	$	2,876,737

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

2

STATE NATIONAL COMPANIES, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME

($ in thousands, except for per share information)

	Three Months Ended				Nine Months Ended
	September 30,		September 30,		September 30,		September 30,
	2017		2016		2017		2016
Revenues:
Premiums earned	$	35,499	$	33,700	$	105,941	$	94,293
Commission income		328		389		926		1,015
Ceding fees		21,697		19,263		60,340		52,424
Net investment income		2,314		2,001		6,753		6,141
Realized net investment gains (losses)		1,010		2,063		3,409		1,707
Other income		597		501		1,658		1,416
Total revenues		61,445		57,917		179,027		156,996
Expenses:
Losses and loss adjustment expenses		15,883		13,755		50,849		42,587
Commissions		1,064		1,408		4,341		4,235
Taxes, licenses, and fees		1,096		960		2,962		2,466
General and administrative		19,666		17,235		57,412		51,377
Interest expense		631		565		1,831		1,655
Total expenses		38,340		33,923		117,395		102,320
Income (loss) before income taxes		23,105		23,994		61,632		54,676
Income taxes:
Current tax expense (benefit)		11,160		10,801		25,420		21,292
Deferred tax expense (benefit)		(2,749)		(2,130)		(3,207)		(1,597)
		8,411		8,671		22,213		19,695
Net income (loss)	$	14,694	$	15,323	$	39,419	$	34,981
Net income (loss) per share attributable to common shareholders:
Basic earnings per share	$	0.35	$	0.37	$	0.95	$	0.83
Diluted earnings per share		0.34		0.37		0.92		0.83
Dividends, per share	$	0.06	$	0.06	$	0.18	$	0.18

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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STATE NATIONAL COMPANIES, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

($ in thousands)

	Three Months Ended				Nine Months Ended
	September 30,		September 30,		September 30,		September 30,
	2017		2016		2017		2016
Net income (loss)	$	14,694	$	15,323	$	39,419	$	34,981
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses)		64		(1,771)		3,627		6,744
Tax effect on unrealized holding (gains) losses		(22)		620		(1,269)		(2,360)
Less: reclassification adjustments for realized (gains) losses included in net income		79		626		(301)		680
Tax effect on reclassification adjustments for realized gains (losses) included in net income		(28)		(219)		105		(238)
Other comprehensive income (loss)		93		(744)		2,162		4,826
Total comprehensive income (loss)	$	14,787	$	14,579	$	41,581	$	39,807

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

4

STATE NATIONAL COMPANIES, INC.

unaudited condensed Consolidated Statements of Shareholders’ Equity

($ in thousands)

							Accumulated
			Additional				Other
	Common		Paid-In		Retained		Comprehensive
	Stock		Capital		Earnings		Income		Total
Balance at December 31, 2015	$	43	$	224,719	$	37,322	$	1,373	$	263,457
Stock-based compensation expense		—		4,578		—		—		4,578
Dividends declared		—		—		(10,139)		—		(10,139)
Repurchase of common stock		(1)		—		(10,030)		—		(10,031)
Net income (loss)		—		—		49,077		—		49,077
Other comprehensive income (loss), net of tax		—		—		—		(562)		(562)
Balance at December 31, 2016		42		229,297		66,230		811		296,380
Stock-based compensation expense		—		3,413		—		—		3,413
Dividends declared		—		—		(7,576)		—		(7,576)
Net income (loss)		—		—		39,419		—		39,419
Other comprehensive income (loss), net of tax		—		—		—		2,162		2,162
Balance at September 30, 2017	$	42	$	232,710	$	98,073	$	2,973	$	333,798

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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STATE NATIONAL COMPANIES, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

($ in thousands)

	Nine Months Ended
	September 30,		September 30,
	2017		2016
Operating activities
Net cash provided by (used in) operating activities	$	52,690	$	48,938
Investing activities
Purchase of investments		(114,829)		(60,754)
Proceeds from sale of investments		47,323		55,120
Proceeds from maturities and principal receipts		29,282		17,679
Proceeds from dispositions of property and equipment		97		78
Purchase of property and equipment		(2,093)		(724)
Acquisition of consolidated subsidiaries, net of cash obtained		(31,980)		(17,320)
Investment in cost-method investee		(650)		—
Net cash provided by (used in) investing activities		(72,850)		(5,921)
Financing activities
Dividends paid		(7,535)		(5,077)
Repurchase of common stock		—		(9,948)
Net cash provided by (used in) financing activities		(7,535)		(15,025)
Net change in cash and cash equivalents		(27,695)		27,992
Cash and cash equivalents at beginning of period		91,698		51,770
Cash and cash equivalents at end of period	$	64,003	$	79,762

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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1. Summary of Significant Accounting Policies

Description of Business

State National Companies, Inc. (the “Company”) refers to a group of companies that conducts insurance-related activities along two major segments.  The Company’s Program Services segment generates fee income, in the form of ceding fees, by offering issuing carrier capacity to both specialty general agents and other producers (“GAs”), who sell, control, and administer books of insurance business that are supported by third parties that assume reinsurance risk.  Substantially all of the underwriting risk associated with the Program Services segment is ceded to unaffiliated, highly rated reinsurance companies or other reinsurers that provide collateral.  The Company’s Lender Services segment generates premiums primarily from the sale of collateral protection insurance (“CPI”), which insures automobiles or other vehicles held as collateral for loans made by credit unions, banks and specialty finance companies.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.  The Company includes the results of operations of an acquired business in its consolidated financial statements from the date of the acquisition.

Basis of Presentation

The unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and include the accounts of the Company and all subsidiaries.  All significant intercompany accounts and transactions have been eliminated in consolidation.  Certain footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial reporting.  These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the years ended December 31, 2016 and 2015.

The interim financial data as of September 30, 2017 and 2016 is unaudited.  However, in the opinion of the Company’s management (“Management”), the interim data includes all adjustments, consisting of normal recurring adjustments, necessary to fairly state the results for the interim period.  The results of operations for the period ended September 30, 2017 and 2016 are not necessarily indicative of the operating results to be expected for the full year.

Refer to “Summary of Significant Accounting Policies” in the consolidated financial statements for the three years in the period ended December 31, 2016 for information on accounting policies that we consider critical in preparing consolidated financial statements.

Estimates

The preparation of financial statements in conformity with GAAP requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods.  Actual results could differ materially from these estimates.

Earnings Per Share

The computation of earnings per share is based upon the weighted average number of common shares outstanding during the period plus the effect of common shares potentially issuable (in periods in which they have a dilutive effect).

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Income Taxes

For any uncertain tax positions not meeting the “more likely than not” recognition threshold, accounting standards require recognition, measurement, and disclosure in the financial statements.  There were no uncertain tax positions at September 30, 2017 and December 31, 2016.

Stock-Based Compensation

Compensation expense for stock-based payments is recognized based on the measurement-date fair value for awards that will settle in shares.  Compensation expense for restricted stock grants and stock option awards that contain a service condition are recognized on a straight line pro rata basis over the vesting period.  For restricted stock awards that contain a performance condition, the expense is recognized based on the awards expected to vest and the cumulative expense is adjusted whenever the estimate of the number of awards to vest changes.  An estimation of future forfeitures of stock-based awards is incorporated into the determination of compensation expense.   See Note 8 — “Stock-based Payments” for related disclosures.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers (Topic 606)” which replaces most existing GAAP revenue recognition guidance to a five-step revenue recognition model.  The FASB has updated the guidance to include the following ASUs:

· ASU 2015-14—“Revenue from Contracts with Customers (Topic 606):  Deferral of the Effective Date”;

· ASU 2016-08—“Revenue from Contracts with Customers (Topic 606):  Principal versus Agent Considerations (Reporting Revenue Gross versus Net)”;

· ASU 2016-10—“Revenue from Contracts with Customers (Topic 606):  Identifying Performance Obligations and Licensing”;

· ASU 2016-11—“Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815):  Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at March 3, 2016 EITF Meeting (SEC Update)”;

· ASU 2016-12—“Revenue from Contracts with Customers (Topic 606):  Narrow-Scope Improvements and Practical Expedients”; and

· ASU 2016-20—“Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers”

The new guidance excludes insurance contracts that are recognized under Topic 944 “Financial Services—Insurance”; however, income related to our agency operations will be recognized under the new guidance.  The model provides for an analysis of transactions to determine when or how revenue is recognized and requires additional disclosures sufficient to describe the nature, amount, timing, and uncertainty of revenue and cash flows for these transactions.  The Company has the option to choose to apply the guidance using either the full retrospective or a modified retrospective approach.  The standards are effective for annual periods beginning after December 15, 2017, including interim reporting periods within that period.  The Company has assessed its revenue streams to identify those contracts that are clearly excluded from the scope of the new standard and those that may be subject to the new standard.  The Company does not anticipate the impact of these ASUs to be material to the Company’s financial position or cash flows. 

In January 2016, the FASB issued ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities” (Sub-Topic 825-10).  The amendment in this update supersedes the guidance to classify equity securities with readily determinable fair value into different categories (either trading or available-for-sale) and requires equity securities to be measured at fair value and changes in the fair value to be recognized through net income instead of other comprehensive income.  This ASU is effective for annual and interim reports beginning after December 15, 2017.  Since the Company’s current position in equities is less than 1% of our current investment portfolio as of September 30, 2017,

8

the Company does not anticipate that the guidance will have a material impact to the Company’s financial statements or cash flows.

In February 2016, the FASB issued ASU 2016-02, “Leases” (Topic 842) that requires lessees to recognize the assets and liabilities related to leases on the balance sheet.  The FASB is issuing this update to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements.  This ASU is effective for annual and interim periods beginning after December 15, 2018.  Early adoption is permitted.  The Company does not plan to early adopt and is currently evaluating what impact this ASU will have on financial results and disclosures.

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.”  The standard will replace today’s “incurred loss” approach with an “expected loss” model for instruments measured at amortized cost and require entities to record allowances for available-for-sale (AFS) debt securities rather than reduce the carrying amount, as they do today under the other-than-temporary impairment (OTTI) model. It also simplifies the accounting model for purchased credit-impaired debt securities and loans.  This ASU is effective for annual and interim periods beginning after December 15, 2019.  The Company will be evaluating what impact this ASU will have on financial results and disclosures. 

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments.”  This ASU amends guidance related to debt prepayment or extinguishment costs, settlement of zero-coupon debt instruments or other debt instruments with coupon rates that are insignificant in relation to the effective interest rate of the borrowing, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims and corporate-owned life insurance, distributions received from equity method investees and beneficial interests in securitization transactions.  The guidance will generally be applied retrospectively and is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those years.  The Company does not expect financial results and disclosures to be significantly impacted by this ASU.

In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash.”  The amendments requireentities to show the changes in the total of cash, cash equivalents, restricted cash and restricted cash equivalents in the statement of cash flows. As a result, entities will no longer present transfers between cash and cash equivalents and restricted cash and restricted cash equivalents in the statement of cash flows.  This ASU is effective for annual and interim periods beginning after December 15, 2017.  The Company will be evaluating what impact this ASU will have on disclosures.

In January 2017, the FASB issued ASU 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business.”  Under the new guidance, if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets, then the transferred assets and activities do not constitute a business. The guidance also requires a business to include at least one substantive process and narrows the definition of outputs by more closely aligning it with how outputs are described in ASC 606.  The ASU is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those years. The ASU will be applied prospectively to any transactions occurring within the period of adoption. Early adoption is permitted, including for interim or annual periods in which the financial statements have not been issued or made available for issuance.  The Company does not plan to early adopt and will be evaluating what impact this ASU will have on financial results and disclosures.

In January 2017, the FASB issued ASU 2017-04, “Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.”  The new guidance eliminates the requirement to calculate the implied fair value of goodwill under step two of the current goodwill impairment test, to measure a goodwill impairment charge.  Instead, entities will record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value based on step one of the current goodwill impairment test.  The standard will be applied prospectively and is effective for annual and interim impairment tests performed in periods beginning after December 15, 2019, for public business entities.  The Company will be evaluating what impact this ASU will have on disclosures.

9

In March 2017, the FASB issued ASU 2017-08, “Premium Amortization on Purchased Callable Debt Securities.”  The amendments in this update shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date.  This ASU is effective for annual and interim periods beginning after December 15, 2018.  The Company will be evaluating what impact this ASU will have on disclosures.

In May 2017, the FASB issued ASU 2017-09, “Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting.”  The amendments in this update provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting.  Modification accounting is not needed if the fair value, vesting conditions and classification of the modified award are the same as the original award immediately before the original award is modified.  This ASU is effective for annual and interim periods beginning after December 15, 2017.  The Company does not expect financial results and disclosures to be significantly impacted by this ASU.

2. Investments

The following table summarizes information on the amortized cost, gross unrealized gains and losses, and the fair value of investment securities by class:

	As of September 30, 2017
	Cost or		Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
($ in thousands)	Cost		Gains		Losses		Value
Fixed-maturity securities
Government	$	39,272	$	108	$	(103)	$	39,277
Government agency		864		16		(2)		878
State and municipality		61,348		1,504		(31)		62,821
Industrial and miscellaneous		181,500		5,314		(1,846)		184,968
Residential mortgage-backed		60,514		605		(437)		60,682
Commercial mortgage-backed		54,793		444		(292)		54,945
Redeemable preferred stock		2,594		561		(49)		3,106
Total fixed-maturity securities		400,885		8,552		(2,760)		406,677
Equity securities
Non-redeemable preferred stock		2,032		247		(175)		2,104
Common stock		7		5		—		12
Total equity securities		2,039		252		(175)		2,116
Total investments	$	402,924	$	8,804	$	(2,935)	$	408,793

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	As of December 31, 2016
	Cost or		Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
($ in thousands)	Cost		Gains		Losses		Value
Fixed-maturity securities
Government	$	28,020	$	87	$	(102)	$	28,005
Government agency		1,522		18		(2)		1,538
State and municipality		57,885		508		(183)		58,210
Industrial and miscellaneous		147,761		3,765		(2,111)		149,415
Residential mortgage-backed		51,237		536		(697)		51,076
Commercial mortgage-backed		40,410		300		(327)		40,383
Redeemable preferred stock		3,159		503		(182)		3,480
Total fixed-maturity securities		329,994		5,717		(3,604)		332,107
Equity securities
Non-redeemable preferred stock		3,267		304		(350)		3,221
Common stock		4		—		(1)		3
Total equity securities		3,271		304		(351)		3,224
Total investments	$	333,265	$	6,021	$	(3,955)	$	335,331

Investment securities are exposed to various risks such as interest rate, market, and credit risk.  Fair values of securities fluctuate based on the magnitude of changing market conditions; significant changes in market conditions could materially affect the portfolio fair value in the near term.

The following tables show the gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:

	As of September 30, 2017
	Less than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
($ in thousands)	Value		Losses		Value		Losses		Value		Losses
Fixed-maturity securities
Government	$	20,927	$	(103)	$	—	$	—	$	20,927	$	(103)
Government agency		522		(2)		—		—		522		(2)
State and municipality		6,966		(31)		—		—		6,966		(31)
Industrial and miscellaneous		52,845		(866)		4,409		(980)		57,254		(1,846)
Residential mortgage-backed		27,994		(240)		7,400		(197)		35,394		(437)
Commercial mortgage-backed		25,351		(226)		1,991		(66)		27,342		(292)
Redeemable preferred stock		180		(22)		161		(27)		341		(49)
Total fixed-maturity securities		134,785		(1,490)		13,961		(1,270)		148,746		(2,760)
Equity securities
Non-redeemable preferred stock		376		(26)		122		(149)		498		(175)
Total equity securities		376		(26)		122		(149)		498		(175)
	$	135,161	$	(1,516)	$	14,083	$	(1,419)	$	149,244	$	(2,935)

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	As of December 31, 2016
	Less than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
($ in thousands)	Value		Losses		Value		Losses		Value		Losses
Fixed-maturity securities
Government	$	19,371	$	(102)	$	—	$	—	$	19,371	$	(102)
Government agency		538		(2)		—		—		538		(2)
State and municipality		21,523		(183)		—		—		21,523		(183)
Industrial and miscellaneous		52,995		(1,485)		2,784		(626)		55,779		(2,111)
Residential mortgage-backed		29,776		(535)		3,338		(162)		33,114		(697)
Commercial mortgage-backed		18,673		(293)		773		(34)		19,446		(327)
Redeemable preferred stock		2,207		(171)		135		(11)		2,342		(182)
Total fixed-maturity securities		145,083		(2,771)		7,030		(833)		152,113		(3,604)
Equity securities
Non-redeemable preferred stock		570		(312)		42		(38)		612		(350)
Common stock		3		(1)		—		—		3		(1)
Total equity securities		573		(313)		42		(38)		615		(351)
	$	145,656	$	(3,084)	$	7,072	$	(871)	$	152,728	$	(3,955)

The determination that a security has incurred an other-than-temporary decline in fair value and the associated amount of any loss recognition requires the judgment of Management and a regular review of the Company’s investments.  Management reviewed all securities with unrealized losses in accordance with the Company’s impairment policy described in Note 1 — “Summary of Significant Accounting Policies” in the consolidated financial statements for each of the three years in the period ended December 31, 2016.  Management believes that the temporary impairments are primarily the result of a combination of widening credit spreads, and higher underlying Treasury rates, and that despite the wider credit spreads and higher rates, the securities are only temporarily impaired due to the strength of the issuing entities’ balance sheets, as well as their available liquidity options.  For structured securities, future cash flow projections were used to determine potential impairment. For those securities where cash flow projections showed less than 100% principal recovery, a net present value test was done to determine any credit related losses.  There were 242 securities in an unrealized loss position at September 30, 2017.  Approximately 96% of these investments are investment-grade at September 30, 2017.  We do not intend to sell or believe we will be required to sell any of our temporarily-impaired fixed maturities before recovery of their amortized cost basis.  Management has the intent and ability to hold the equity securities in an unrealized loss position until the recovery of their fair value.  Therefore, Management does not consider these investments to be other-than-temporarily impaired at September 30, 2017.

Proceeds from sales of investments in fixed-maturity, equity and short-term securities for the nine months ended September 30, 2017 and 2016 were $47.3 million and $55.1 million, respectively.

The Company holds convertible securities with embedded derivatives.  The embedded derivative is bifurcated from the host contract if all of the following criteria are met: the combined instrument is not accounted for in its entirety at fair value with changes in fair value recorded in earnings; the terms of the embedded derivative are not clearly and closely related to the economic characteristics of the host contract; and a separate instrument with the same terms as the embedded derivative would qualify as a derivative instrument.  These embedded derivatives are presented together with the host contract and carried at estimated fair value.  Changes in the estimated fair value of the embedded derivatives are reflected in “Realized net investment gains (losses)” in the condensed consolidated statements of income, while changes in the estimated fair value of the underlying fixed maturity securities are reflected in “Unrealized holding gains (losses)” in the condensed consolidated statements of comprehensive income.

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The following table presents the Company’s gross realized gains (losses) for the periods ended:

	Three Months Ended				Nine Months Ended
	September 30,		September 30,		September 30,		September 30,
($ in thousands)	2017		2016		2017		2016
Realized gains:
Fixed-maturity securities	$	969	$	1,134	$	3,522	$	2,146
Equity securities		—		497		5		573
Gross realized gains		969		1,631		3,527		2,719
Realized losses:
Fixed-maturity securities		(170)		(205)		(593)		(615)
Equity securities		—		(35)		(2)		(133)
Other-than-temporary impairment losses on fixed-maturity securities		—		—		—		(90)
Gross realized losses		(170)		(240)		(595)		(838)
Change in fair value of embedded derivatives		211		672		477		(174)
Net realized investment gains (losses)	$	1,010	$	2,063	$	3,409	$	1,707

The Company had seven non-cash exchanges of investment securities for the nine months ended September 30, 2017 and two non-cash exchanges for the nine months ended September 30, 2016.  Non-cash consideration received for these exchanges was $1.5 million and $533 thousand for the nine months ended September 30, 2017 and September 30, 2016.  Gains of $150 thousand and $153 thousand were recognized on these exchanges and are reflected in “Realized net investment gains (losses)” on the condensed consolidated statements of income.

The following schedule details the maturities of the Company’s available-for-sale fixed-maturity securities:

	As of September 30, 2017
($ in thousands)	Amortized Cost		Fair Value
Due in one year or less	$	16,126	$	16,471
Due after one year through five years		136,335		138,915
Due after five years through ten years		115,806		117,204
Due after ten years		17,311		18,460
Residential mortgage-backed securities		60,514		60,682
Commercial mortgage-backed securities		54,793		54,945
	$	400,885	$	406,677

Expected maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

The Company’s investment portfolio includes approximately $0.7 million of mortgage-backed securities collateralized by subprime residential loans, which represent approximately 0.17% of the Company’s total investments as of September 30, 2017.  The Company does not own mortgage derivatives.

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Net investment income for the periods ended, consists of the following:

	Three Months Ended				Nine Months Ended
	September 30,		September 30,		September 30,		September 30,
($ in thousands)	2017		2016		2017		2016
Interest on investments	$	2,481	$	2,074	$	7,206	$	6,409
Dividends		85		148		271		387
Gross investment income		2,566		2,222		7,477		6,796
Investment expenses		(252)		(221)		(724)		(655)
Net investment income	$	2,314	$	2,001	$	6,753	$	6,141

The Company’s insurance subsidiaries are required to maintain deposits in various states where they are licensed to operate.  These deposits consist of fixed-maturity securities at fair values totaling $80.3 million and $77.0 million at September 30, 2017 and December 31, 2016, respectively.

3. Income Tax Provision

The Company computes its provision for income taxes in interim periods by applying its estimated annual effective tax rate against income (loss) before income taxes for the period.  In addition, non-recurring or discrete items are recorded during the period in which they occur.  The magnitude of the impact that discrete items have on the Company’s quarterly effective tax rate is dependent on the level of income in the period.  A reconciliation of federal income tax expense computed by applying the federal statutory tax rate to income (loss) before income taxes for the periods ended is as follows:

	Nine Months Ended
	September 30, 2017				September 30, 2016
			Effective				Effective
($ in thousands)	Amount		Tax Rate		Amount		Tax Rate
Expected tax expense (benefit)	$	21,571	35.0	%	$	19,137	35.0	%
Tax-exempt income		(266)	(0.4)			(332)	(0.6)
State income taxes		1,015	1.6			948	1.7
Other		(107)	(0.2)			(58)	(0.1)
Total income tax expense (benefit)	$	22,213	36.0	%	$	19,695	36.0	%

4. Reinsurance

Through unaffiliated general agents, the Company’s insurance subsidiaries write property and casualty lines of business in the Program Services segment.  This business is written and reinsured pursuant to quota share and excess of loss reinsurance contracts and general agency agreements that are typically tripartite agreements executed by the Company’s insurance subsidiaries, the reinsurer, and the general agent.  Substantially all of the underwriting risk associated with this business is borne by the reinsurer.  As compensation for writing this business, the Company’s insurance subsidiaries receive ceding fees from the producers and, accordingly, the related ceding fees receivable are reflected as “Accounts receivable from agents, net”. Typically, if the GA defaults on its obligation to pay these fees (or any other amount due), the reinsurer is obligated to make the payment under the guarantee contained in the tripartite contracts.  The Company recently entered into a limited number of large programs, in which certain qualifying criteria were met, where the Company retains the risk associated with such obligations.  In these instances, the net premiums receivable are also reflected as “Accounts receivable from agents, net”, and the net premiums payable to the reinsurers are reflected as “Accounts payable to insurance companies”.

Through our Lender Services segment, the Company is party to a reinsurance agreement in which it cedes 30% of certain CPI policies to CUMIS Insurance Society, Inc. (“CUNA Mutual”) and receives a ceding commission related to these policies.

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The Company’s insurance subsidiaries remain liable for unearned premiums and unpaid losses and loss adjustment expenses with respect to reinsurance ceded should the reinsurer be unable to meet its obligations.  Management considers the possibility of a reinsurer becoming unable to meet its obligations as remote due to the reinsurers’ financial stability, A.M. Best Company rating, size, security funds available, and other factors as appropriate.  Following is a summary of these balances:

	September 30,		December 31,
($ in thousands)	2017		2016
Ceded unearned premiums	$	796,679	$	651,938
Ceded loss and loss adjustment expense reserves		2,074,821		1,690,926
Total reinsurance recoverables		2,871,500		2,342,864
Secured reinsurance recoverables		(1,826,824)		(1,678,243)
Unsecured reinsurance recoverables	$	1,044,676	$	664,621

The fair value of all collateral held by the Company’s insurance subsidiaries for reinsurers for whom we require collateral is approximately 143% of the related reinsurance recoverables as of September 30, 2017, with the lowest ratio for any such reinsurer being 100%.

5. Fair Value Measurements

Assets and liabilities reported in the condensed consolidated financial statements at fair value are required to be classified according to a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies into three levels.  The hierarchy gives the highest ranking to fair values determined using unadjusted quoted prices in active markets for identical assets and liabilities (Level 1) and the lowest ranking to fair values determined using methodologies and models with unobservable inputs (Level 3).  An asset’s or liability’s classification is based on the lowest level input that is significant to its measurement.  For example, a Level 3 fair value measurement may include inputs that are both observable (Level 1 and 2) and unobservable (Level 3).  The levels of the fair value hierarchy are as follows:

· Level 1: Inputs are quoted prices for identical assets or liabilities in active markets that are accessible at the measurement date.

· Level 2: Inputs include quoted prices for similar assets or liabilities in active markets, quoted prices from those willing to trade in markets that are not active, or other inputs that are observable or can be corroborated by market data for the term of the instrument.  These inputs include market interest rates and volatilities, spreads, and yield curves.

· Level 3: Inputs are unobservable.  Unobservable inputs reflect the Company’s own assumptions about the assumptions market participants would use in pricing the asset or liability based on the best information available in the circumstances.

A description of the Company’s valuation techniques used to measure its assets at fair value is as follows:

· Available-for-sale, fixed-maturity securities: All fixed-maturity investments are currently reported at fair value utilizing Level 2 inputs.  For these securities, the Company obtains fair value measurements from either an independent pricing service using quoted prices or from its third-party investment managers.  These Level 2 inputs are valued by either the pricing service or the investment managers utilizing observable data that may include dealer quotes, market spreads, cash flows, yield curves, live trading levels, trade execution data, market consensus, prepayment speeds, credit information, and the security’s terms and conditions, among other things.  Securities are recorded at estimated fair value with changes in estimated fair value reported in the consolidated statements of comprehensive income.

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· Available-for-sale equity securities: Equity securities are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service using quoted prices or from its third-party investment managers. These Level 2 inputs are valued by either the pricing service or the investment managers utilizing observable data that may include dealer quotes, market spreads, cash flows, yield curves, live trading levels, trade execution data, market consensus, prepayment speeds, credit information, and the security’s terms and conditions, among other things.  Securities are recorded at estimated fair value with changes in estimated fair value reported in the consolidated statements of comprehensive income.

· Embedded derivatives: The Company invests in convertible securities that have embedded derivatives. Embedded derivatives are recorded at estimated fair value with changes in estimated fair value reported in the consolidated statements of net income. The estimated fair value of the embedded derivatives is calculated by the Company’s third-party investment managers using observable inputs.

Management has reviewed the processes used by the pricing services and has determined that they result in fair values consistent with requirements for Level 1 and Level 2 investment securities.  Based on an analysis of the inputs, the Company’s investments measured at fair value on a recurring basis have been categorized as follows:

	As of September 30, 2017
($ in thousands)	Level 1		Level 2		Level 3		Total
Fixed-maturity securities
Government	$	—	$	39,277	$	—	$	39,277
Government agency		—		878		—		878
State and municipality		—		62,821		—		62,821
Industrial and miscellaneous		—		184,968		—		184,968
Residential mortgage-backed		—		60,682		—		60,682
Commercial mortgage-backed		—		54,945		—		54,945
Redeemable preferred stock		—		3,106		—		3,106
Total fixed-maturity securities		—		406,677		—		406,677
Equity securities
Non-redeemable preferred stock		—		2,104		—		2,104
Common stock		6		6		—		12
Total equity securities		6		2,110		—		2,116
Total investments	$	6	$	408,787	$	—	$	408,793

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	As of December 31, 2016
($ in thousands)	Level 1		Level 2		Level 3		Total
Fixed-maturity securities
Government	$	—	$	28,005	$	—	$	28,005
Government agency		—		1,538		—		1,538
State and municipality		—		58,210		—		58,210
Industrial and miscellaneous		—		149,415		—		149,415
Residential mortgage-backed		—		51,076		—		51,076
Commercial mortgage-backed		—		40,383		—		40,383
Redeemable preferred stock		—		3,480		—		3,480
Total fixed-maturity securities		—		332,107		—		332,107
Equity securities
Non-redeemable preferred stock		—		3,221		—		3,221
Common stock		—		3		—		3
Total equity securities		—		3,224		—		3,224
Total investments	$	—	$	335,331	$	—	$	335,331

The fair value of embedded derivatives included in Level 2 securities was $10.5 million at September 30, 2017 and $9.5 million at December 31, 2016, respectively.

There was no Level 3 activity including gains or losses recognized, purchases, or sales transaction during the periods ending September 30, 2017 and December 31, 2016.

Transfers between levels are recognized at the end of the reporting period.  There were no transfers between Level 1, Level 2, and Level 3 at September 30, 2017 and December 31, 2016.

6. Losses and Loss Adjustment Expenses

The following table shows the activity in the liability for unpaid losses and loss adjustment expenses:

	Nine Months Ended September 30,
($ in thousands)	2017		2016
Balance at January 1,	$	1,703,706	$	1,364,774
Reinsurance recoverables		(1,690,926)		(1,352,022)
Net balance at January 1,		12,780		12,752
Incurred related to:
Current year		49,415		41,692
Prior year		1,434		895
Total incurred		50,849		42,587
Paid related to:
Current year		39,153		34,037
Prior year		11,356		9,848
Total paid		50,509		43,885
Net balance at September 30,		13,120		11,454
Reinsurance recoverables		2,074,821		1,643,451
Balance at September 30,	$	2,087,941	$	1,654,905

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7. 401(k) Profit-Sharing Plan and Trust

The Company has a 401(k) profit-sharing plan for employees that covers all officers and employees who are at least 18 years of age.  The Company is required to make a matching contribution of 100% of the first 1% and 50% of the next 5% of employees’ contributions.  Also, the Company may make additional matching and profit-sharing contributions that are discretionary and are determined at the end of each plan year.  The employer contribution expense included in general and administrative expenses was $375 thousand for the three months ended September 30, 2017 and $347 thousand for the three months ended September 30, 2016.   The employer contribution expense included in general and administrative expenses was $1.2 million for the nine months ended September 30, 2017 and $1.1 million for the nine months ended September 30, 2016.

8. Stock-based Payments

On May 18, 2017, the Company’s shareholders approved the First Amended and Restated 2014 Long-Term Incentive Plan (“2014 Plan”), which provides for an aggregate of 6.4 million shares of our common stock that may be issued to employees and non-employee directors.  Awards under the 2014 Plan may be in the form of stock options (including incentive stock options that meet the requirements of Section 422 of the Internal Revenue Code and non-statutory stock options), restricted stock, restricted stock units, stock appreciation rights and performance units.

The fair value of the restricted shares granted is determined based on the most recent trading price of the stock as of the grant date.  The fair value of each stock option grant is established on the grant date using the Black-Scholes option pricing model.  

A summary of the Company’s restricted shares and stock options activity is shown below:

		Weighted-Average			Weighted-Average
	Restricted	Grant Date Fair Value		Stock	Grant Date Fair Value
September 30, 2017	Shares	per Restricted Share		Options	per Stock Option
Nonvested at January 1, 2017	278,050	$	11.52	1,502,963	$	2.73
Granted	249,121		14.36	—		—
Vested	(37,305)		11.37	(1,119,629)		3.00
Nonvested at September 30, 2017	489,866		12.98	383,334		1.93

		Weighted-Average			Weighted-Average
	Restricted	Grant Date Fair Value		Stock	Grant Date Fair Value
September 30, 2016	Shares	per Restricted Share		Options	per Stock Option
Nonvested at January 1, 2016	144,362	$	10.05	1,855,918	$	3.22
Granted	211,383		12.00	575,000		1.93
Vested	(11,028)		10.88	(927,955)		3.22
Nonvested at September 30, 2016	344,717		11.22	1,502,963		2.73

Compensation expense for all share-based compensation was $1.1 million for the three months ended September 30, 2017 and $1.2 million for the three months ended September 30, 2016.  Compensation expense for all share-based compensation was $3.4 million for the nine months ended September 30, 2017 and $3.1 million for the nine months ended September 30, 2016. 

9. Concentration of Risk

The Company maintains cash and cash equivalents in accounts with financial institutions in excess of the amount insured by the Federal Deposit Insurance Corporation.  The Company monitors the financial stability of these institutions

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regularly, and Management does not believe there is significant credit risk associated with deposits in excess of federally insured amounts.

The Company’s writings in California, Texas, Florida and New York comprised 58% and 57% of gross premiums written for the periods ending September 30, 2017 and 2016, respectively.  The top five general agents comprised 52% and 62% of gross premiums written in the Program Services segment for the periods ending ended September 30, 2017 and 2016, respectively.  The four largest reinsurers with unsecured reinsurance recoverables, all of which are rated A or higher by A.M. Best, accounted for approximately 21%, 12%, 8%, and 7% of the Company’s unsecured reinsurance recoverables at September 30, 2017.

10.  Commitments and Contingencies

The Company is involved in various legal proceedings incidental to its normal business activities.  Management of the Company does not anticipate that the outcome of such legal actions will have a material effect on the Company’s consolidated financial position or results of operations.

The Company’s insurance subsidiaries are subject to assessments from various insurance regulatory agencies related to insurance company insolvencies.  Management is not aware of any material assessments for which notice has not yet been received.  However, to the extent that such assessments are made, the Company has the contractual right to recover these amounts from the underlying reinsurers.

The Company has a Collateral Protection Alliance (the “Alliance”) with CUMIS Insurance Society, Inc., a subsidiary of CUNA Mutual, to administer and write CPI business for credit union customers.  The Alliance includes an agency agreement and a reinsurance agreement whereby the Company cedes a portion of the business to CUNA Mutual.  In connection with the Alliance, the Company has a purchase option and CUNA Mutual has a put option, whereby the Company is obligated to purchase CUNA Mutual’s right to participate in future program business at a specified price in the event of termination of the Alliance.  The Alliance’s current term ends on July 31, 2018.  The Company anticipates continued negotiations with CUNA Mutual to revise and extend the term of the contract.  In the event the Alliance is not revised and extended, the Company expects to purchase CUNA Mutual’s remaining quota share participation.  The Company estimates payments totaling approximately $27 million as of September 30, 2017 related to the termination of the agreement. 

11. Earnings Per Share

A reconciliation of the numerators and denominators of the basic and diluted per share calculations is presented below:

	Three Months Ended				Nine Months Ended
	September 30,		September 30,		September 30,		September 30,
($ in thousands, except for per share amounts)	2017		2016		2017		2016
Numerator for both basic and diluted earnings per share:
Net income (loss)	$	14,694	$	15,323	$	39,419	$	34,981
Denominator for both basic and diluted earnings per share:
Weighted-average common shares outstanding		41,683,695		41,937,467		41,655,636		42,196,075
Dilutive effect of outstanding securities (determined using the treasury stock method)		1,729,207		3,451		1,311,666		19,771
Weighted-average common shares outstanding and potential common shares outstanding		43,412,902		41,940,918		42,967,302		42,215,846

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12. Segment Information

The following is business segment information for the periods indicated:

	Three Months Ended				Nine Months Ended
	September 30,		September 30,		September 30,		September 30,
($ in thousands)	2017		2016		2017		2016
Revenues:
Program	$	21,697	$	19,266	$	60,340	$	52,427
Lender		36,381		34,577		108,494		96,715
Corporate		3,367		4,074		10,193		7,854
Consolidated revenues	$	61,445	$	57,917	$	179,027	$	156,996
Income (loss) before income taxes:
Program	$	17,695	$	15,485	$	47,963	$	40,608
Lender		7,668		8,292		16,852		17,049
Corporate		(2,258)		217		(3,183)		(2,981)
Consolidated income (loss) before income taxes	$	23,105	$	23,994	$	61,632	$	54,676

The following table summarizes the financial assets of the Company’s segments as of the periods indicated:

	September 30,		December 31,
($ in thousands)	2017		2016
Assets:
Program	$	3,042,300	$	2,382,466
Lender		21,568		17,824
Corporate		526,837		476,447
	$	3,590,705	$	2,876,737

13. Debt

Between 2002 and 2004, the Company, through its subsidiary T.B.A. Insurance Group, Ltd. (“TBA”), formed three business trusts (the “Trusts”) for the sole purpose of issuing, in private placement transactions, $44.5 million of trust preferred securities (“TPS”).  In turn, the Trusts used the proceeds thereof, together with the equity proceeds received from TBA upon their initial formation, to purchase variable-rate subordinated debentures (“TPS Debentures”) issued by TBA.  All voting securities of the Trusts are owned by TBA, and the TPS debentures are the sole assets of the Trusts.  The Trusts meet the obligations of the TPS with the interest and principal paid on the TPS debentures.  The Company does not have a variable interest in the Trusts and therefore does not consolidate the Trusts.  These debentures’ interest rates range from 3.80% to 4.10% plus the three-month LIBOR.  All of the debentures mature between 2032 and 2034 and are reflected net of debt issuance costs in the condensed consolidated balance sheets.

On March 31, 2016, TBA entered into a loan agreement (“credit agreement”), which provides for a secured revolving credit facility in an aggregate principal amount of $15 million.  The credit agreement matures on April 30, 2018.  Under the credit agreement, TBA may request advances up to the aggregate amount of the unused commitment under the credit facility, on a revolving basis, prior to the maturity of the credit agreement.  Borrowings under the credit agreement will bear interest at a variable rate equal to LIBOR plus 1.85% per annum; provided, however, that LIBOR shall be subject to a floor of 0.15%.  TBA shall also pay a commitment fee on the daily average unused commitment amount for the period running from the closing date to the maturity date at a rate of 0.125% per annum.  The credit agreement contains customary representations, warranties, covenants, and events of default, as well as a financial covenant requiring TBA and the Company to maintain a consolidated tangible net worth of at least $150 million. TBA’s obligations under the

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credit agreement are guaranteed by the Company and are secured by a securities account in the name of TBA and maintained with the creditor, in which TBA must maintain assets with a market value of at least $25 million.

14. Business Combinations

Effective January 1, 2017, (“the acquisition date”), the Company acquired 100% of the outstanding common shares of Fireman’s Fund Insurance Company of Ohio,  which was subsequently renamed Independent Specialty Insurance Company (“ISIC”).  ISIC is an excess and surplus lines, or non-admitted, shell company.The purpose of the acquisition is to provide a dedicated insurance carrier for one of our programs. 

The acquisition date fair value of the consideration transferred totaled $49.4 million in cash.  The following table summarizes the estimated fair values of assets acquired and liabilities assumed at the acquisition date. 

($ in thousands)
Cash and cash equivalents	$	17,400
Fixed-maturity securities		29,611
Reinsurance recoverables		45,127
Interest receivable		142
Goodwill and intangible assets, net		2,300
Other receivables		107
Total identifiable assets acquired	$	94,687
Unpaid losses and loss adjustment expenses	$	45,127
Other liabilities		180
Total liabilities assumed		45,307
Net assets acquired	$	49,380

ISIC was acquired as a shell company with a 100% quota share reinsurance agreement.  There was no income statement impact resulting from the acquisition.  There is no goodwill to assign to reporting segments.  The indefinite lived intangible asset is assigned to the Program Services segment.  The Company recognized $29 thousand of acquisition related costs that were expensed in the current period.  These costs are included in the condensed consolidated statements of income as “General and administrative” expenses.

15. Merger

On July 26, 2017, the Company entered into a definitive agreement with Markel Corporation (“Markel”) to acquire all of the outstanding shares of the Company’s common stock for $21.00 per share cash.  Upon the completion of the transaction, the Company will be a direct, wholly-owned subsidiary of Markel.  The transaction is subject to the approval of relevant state insurance regulators and other customary closing conditions.  The transaction is expected to close in the fourth quarter of 2017. 

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Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking and Other Statements

Various statements contained in this Form 10-Q are forward-looking statements made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995.  These forward-looking statements may include projections and estimates concerning the timing and success of specific projects and the Company’s future production, revenues, income and capital spending.  The Company’s forward-looking statements are generally, but not always, accompanied by words such as “estimate,” “believe,” “expect,” “will,” “plan,” “target,” “could” or other words that convey the uncertainty of future events or outcomes.

There can be no assurance that actual developments will be those anticipated by us, and therefore you are cautioned not to place undue reliance on the Company’s forward-looking statements.  Actual results may differ materially from those expressed or implied in these statements as a result of significant risks and uncertainties, including, but not limited to, our ability to recover from our capacity providers, the cost and availability of reinsurance coverage, challenges to our use of issuing carrier or fronting arrangements by regulators or changes in state or federal insurance or other statutes or regulations, our dependence on a limited number of business partners, potential regulatory scrutiny of collateral protection insurance, level of new car sales, availability of credit for vehicle purchases and other factors affecting automobile financing, our ability to compete effectively, a downgrade in the financial strength ratings of our insurance subsidiaries, our ability to accurately underwrite and price our products and to maintain and establish accurate loss reserves, changes in interest rates or other changes in the financial markets, the effects of emerging claim and coverage issues, changes in the demand for our products, the effect of general economic conditions, breaches in data security or other disruptions with our technology, and changes in pricing or other competitive environments.

Forward-looking statements involve inherent risks and uncertainties that are difficult to predict and many of which are beyond the Company’s control.  The Company cautions readers that various factors could cause its actual financial and operational results to differ materially from those indicated by forward-looking statements made from time-to-time in news releases, reports, proxy statements, registration statements, and other written communications, as well as oral statements made from time to time by representatives of the Company.  These and other important factors, including those contained in Item 1A, "Risk Factors” in the 2016 Annual Report on Form 10-K, may cause our actual results, performance or achievements to differ materially from any future results, performance or achievements expressed or implied by these forward-looking statements.  The forward-looking statements contained in this Form 10-Q speak only as of the date hereof, and the Company undertakes no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.

Overview

We are a leading specialty provider of property and casualty insurance services operating in two niche markets across the United States.  In our Program Services segment, we leverage our “A” (Excellent) A.M. Best rating, expansive licenses and reputation to provide access to the U.S. property and casualty insurance market in exchange for ceding fees.  In our Lender Services segment, we specialize in providing collateral protection insurance (“CPI”), which insures personal automobiles and other vehicles held as collateral for loans made by credit unions, banks and specialty finance companies.

Our Program Services segment generates significant fee income, in the form of ceding fees, by offering issuing carrier (“fronting”) capacity to both specialty general agents and other producers (“GAs”), who sell, control, and administer books of insurance business that are supported by third parties that assume reinsurance risk.  These reinsurers are domestic and foreign insurers and institutional risk investors (“capacity providers”) that want to access specific lines of U.S. property and casualty insurance business.  Issuing carrier arrangements refer to our business in which we write insurance on behalf of a capacity provider and then reinsure the risk under these policies with the capacity provider in exchange for ceding fees.  We reinsure substantially all of the underwriting risks in connection with our fronting arrangements to our capacity providers.  As such, this segment generates significant gross premiums without net premiums (except for the run-off of the retained business as described below).  In many cases, we hold significant

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collateral to secure the associated reinsurance recoverables.  Furthermore, to the extent funds related to settling balances (premiums, commissions and losses) between the GAs and the reinsurers are not the obligation of the Company, no receivables or payables are reflected in the Company’s financial statements for these amounts.  In exchange for providing our insurance capacity, licensing and rating to our GA and insurer clients, we receive ceding fees averaging in excess of 5% of gross written premiums.

Our Lender Services segment generates premiums primarily from providing CPI to our credit union, bank and specialty finance company clients.  Lenders purchase CPI to provide coverage for automobiles or other vehicles of borrowers who do not uphold their obligation to insure the collateral underlying the loan.  Our lender clients pay us directly for CPI and then add the cost of CPI to the borrower’s loan.  Our CPI business is fully vertically integrated: we manage all aspects of the CPI business cycle, including sales and marketing, policy issuance, policy administration, underwriting and claims handling.

Recent Developments

On July 26, 2017, the Company entered into a definitive agreement with Markel Corporation (“Markel”) to acquire all of the outstanding shares of the Company’s common stock for $21.00 per share cash. Upon the completion of the transaction, the Company will be a direct, wholly-owned subsidiary of Markel.  The transaction is subject to the approval of relevant state insurance regulators and other customary closing conditions.  The transaction is expected to close in the fourth quarter of 2017. 

Factors Affecting Our Operating Results

Trending Market Opportunities.  We believe that macroeconomic conditions will provide us with growth opportunities in each of our business segments.  Continued high levels of automobile sales should expand lenders’ loan portfolios to improve our Lender Services results.  Over the past decade, significant alternative capital has entered the reinsurance market.  This influx of capital has had the effect of compressing rates for reinsurance, which in the past was primarily written to reinsure catastrophe-exposed property insurance.  These lower reinsurance rates are now driving industry capital to seek opportunity in U.S. primary insurance markets for both property and casualty lines.  These market dynamics should provide growth opportunities in our Program Services segment.

In our Lender Services business, we believe that organic growth from our existing lender clients will be driven by overall growth in lenders’ portfolios as a result of continued high levels of automobile sales, higher average automobile loan balances and an aging U.S. automobile fleet.  We also expect that growth in the volume of Lender Services clients will produce additional premiums.

We have a Collateral Protection Alliance (the “Alliance”) with CUNA Mutual to administer and write CPI business for credit union customers.  The Alliance includes an agency agreement and a reinsurance agreement whereby we cede a portion of the business to CUNA Mutual.  In connection with the Alliance, we have an option to purchase CUNA Mutual’s right to participate in future program business at a specified price in the event of termination of the Alliance.  The Alliance’s current term ends on July 31, 2018.  We anticipate continued negotiations with CUNA Mutual to revise and extend the term of the contract.  In the event the Alliance is not revised and extended, we expect to purchase CUNA Mutual’s remaining quota share participation.  We estimate payments totaling approximately $27 million as of September 30, 2017 related to the termination of the agreement.  The Company expects to recoup the expense related to the termination through additional underwriting profits over approximately three years.

We believe that the increased role of capital market alternatives to reinsurance, including the capitalization of hedge fund-backed reinsurers and the availability of capital in the non-U.S. reinsurance market, is driving demand for our Program Services, as these firms typically do not have direct access to the U.S. insurance market.  We are well positioned to meet this demand due to our highly rated and broadly licensed insurance subsidiaries in addition to our proven model to provide fronting for a fee.

We currently have a significant program with Nephila Capital, Ltd. (“Nephila”) under which we granted Nephila the exclusive right to utilize the Company as issuing carrier for U.S. catastrophe exposed property insurance from 2015

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through 2019.  Nephila is a hedge fund with approximately $11 billion in assets under management that participates in the market for catastrophe exposed property business.  In exchange for this exclusive right, Nephila has agreed to pay State National contractual minimum ceding fees totaling $66.5 million through 2019. The minimum ceding fees are subject to State National maintaining its “A” A.M. Best rating and potential reductions to the extent that State National is unable to provide production year capacity or is otherwise constrained from writing premium.  Also, under certain circumstances, Nephila may terminate the exclusivity, which would reduce the contractual minimum ceding fees to a total of $32.5 million for 2016 through 2019.  In the event of such a termination, State National would have the ability to write the catastrophe exposed property business for other capacity providers.  The timing and actual amount of gross premiums written for Nephila will impact the timing and amount of ceding fees earned each period under this program.  See “—Principal Revenue and Expense Items—Minimum ceding fees.”  In addition, State National and Nephila have an alliance under which State National acquired City National Insurance Company (“CNIC”), an admitted property and casualty insurance shell company and Independent Specialty Insurance Company (“ISIC”), a non-admitted property and casualty insurance shell company, which will be dedicated to writing business produced by Nephila.  Nephila will have a three year option to purchase these companies beginning three years after the shell companies first write premium. In the event that the option is exercised, contractual minimum payments to State National will extend for an additional two years. 

On May 1, 2017, the Company announced the addition of two significant clients in its Program Services business segment. These clients both bring existing books of business to State National, and combined, we expect them to produce approximately $200 million in annual premiums.  These large programs are written through a program manager of a large national broker and a specialty managing general agent, both of which are well-established organizations that provide specialty insurance solutions in the U.S.  These two new clients began writing premium with the Company in the second quarter of 2017.

Run-off of the Retained Business.  In the past, the Company has participated to a limited extent on a quota share basis in certain programs in the Program Services segment.  From 2007 until 2011, California had required United Specialty Insurance Company (“USIC”) to retain 10% of the risks written.  After this requirement was lifted in early 2012, the Company reinsured to inception the retained business under most of the active contracts, but others continue to run-off.  The Company has no active retained contracts and has no present intention of participating in future contracts.  We refer to this business as “the run-off of the retained business.”  As of September 30, 2017, we had net reserves of $2.9 million related to this business.

Seasonality of Our Business.  Our Lender Services segment typically experiences seasonal fluctuations in written premium.  The third and fourth quarters tend to generate the greatest amount of written premium, whereas the first quarter of the year tends to generate the least.  We believe this trend follows loan delinquency patterns for the industry.  This premium seasonality can also impact the quarterly loss ratio.  We generally do not experience seasonality in our Program Services segment. 

Principal Revenue and Expense Items

Premiums earned.  Premiums earned are the earned portion of our net premiums written, which are predominately CPI premiums.  As the CPI product is not a traditional insurance product, the premium recognition is likewise different.  We do not record premiums until we collect them from our accounts since they have the right to waive the placement of insurance on any of their loans.  There is a high level of policy cancellations since borrowers often purchase insurance at the traditional rates that provides protection for them in addition to their lender.  Due to this high level of policy cancellations, we split the premium into two pieces:  (1) an allowance for future cancellations and (2) premiums that we expect to earn, which we refer to as “stick premiums.”  We earn stick premiums on a pro rata basis over the terms of the policies.  The CPI premiums written as presented in this document reflect the effects of the allowance for policy cancellations including any adjustments related to re-estimation of the allowance.  As such, our recorded CPI premiums written are those that we expect to earn while those that are expected to cancel are included in the allowance for policy cancellations.  At the end of each reporting period, stick premium written that is not earned is classified as unearned premium, which is earned in subsequent periods over the remaining terms of the policies.  Our

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policies typically have a term of one year, although the average duration of our CPI policies is typically less than six months due to policy cancellations.

Ceding fees.  Ceding fees are fees we receive in the Program Services segment in exchange for providing access to the U.S. property and casualty insurance market and are based on the gross premiums we write on behalf of our GA and capacity provider clients.  We earn ceding fees in a manner consistent with the recognition of the gross premiums earned on the underlying insurance policies, generally on a pro-rata basis over the terms of the policies reinsured, which policies often have a one year term.

Minimum ceding fees.  Minimum ceding fees are fees we receive pursuant to contractual minimum premium requirements for certain of our programs where either significant premium capacity is reserved for that program or where the expected premium volume is not reasonably assured.  For those programs where a minimum applies, the ceding fees are considered as two distinct pieces (1) “premium related fees,” which are earned as the associated gross written premium is earned, typically pro rata on an annual basis; and (2) “capacity fees,” which are determined based on the shortfall, if any, between the program’s contractual annual premium minimum and the amount of premium that we estimate will be written in the contract year, which fees are earned over the contract year.

At the end of each quarter during the program contract year, we adjust the capacity fee based upon the re-estimated or actual amount of gross premiums that we expect will be written or that were written for that program for the full contract year.  If the estimated annual gross written premiums fall below the minimum contract level in a given period, capacity fees associated with the estimated premium shortfall for that period are earned in that period.  If the estimated annual gross written premiums equal or exceed the required minimum level for a given period, no capacity fees are recognized for that period, and the premium related fees are earned as the associated gross written premium is earned.  In connection with our re-estimation process, if in a subsequent period we increase our estimate of the amount of gross premiums that we expect will be written under a program for the full contract year, we will reverse a portion of the capacity fees earned in a prior period.  Conversely, to the extent that we decrease our estimate of gross premiums, we will recognize capacity fees associated with the additional shortfall in the current period.

Losses and loss adjustment expenses.  Losses and loss adjustment expenses (“LAE”) include claims paid, estimates of future claim payments, changes in those estimates from prior reporting periods and costs associated with investigating, defending and servicing claims.  We record loss and LAE related to estimates of future claim payments based on historical experience.  We seek to establish all reserves at the most likely ultimate exposure based on historical claims experience.  We revise our estimates as we receive additional information about claims and the total costs of settlement.

Commissions.  Substantially all commission expenses are related to our Lender Services segment.  A significant portion of these amounts are paid to financial institutions as a means to reimburse the financial institution for costs associated with operating a CPI program.  These commissions are partially offset by a 21% ceding commission received under our quota reinsurance agreement with CUNA Mutual and the reimbursement we received from CUNA Mutual for 30% of direct commissions and other reimbursable expenses paid to accounts.  The ceding commission compensates us for expenses, such as underwriting and policy acquisition expenses, that we incur in connection with the writing of the ceded business.

General and administrative expense.  General and administrative expense is composed of all other operating expenses, including various departmental salaries and benefits expense for employees.  General and administrative expense also includes expenses related to our office space, postage, telephone and information technology charges, as well as legal and auditing fees and corporate travel.  In addition, general and administrative expense includes those charges that are related to the amortization of tangible and intangible assets.

Stock-based compensation expense.  Compensation expense for stock-based payments is recognized based on the measurement-date fair value for awards that will settle in shares.  Compensation expense for restricted stock grants and stock option awards that contain a service condition are recognized on a straight line pro rata basis over the vesting period.  For restricted stock awards that contain a performance condition, the expense is recognized based on the awards expected to vest and the cumulative expense is adjusted whenever the estimate of the number of awards to vest changes.

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Ratios

Program Services Ratio

Gross leverage.  Gross leverage for the Company is the ratio of gross written premiums and gross liabilities to surplus.  A significant portion of our capital is used to support the gross premium and insurance liabilities in our Program Services segment.  We reinsure substantially all of the underwriting risk to the capacity providers.  We remain exposed to the credit risk of the capacity providers, but by maintaining strict credit underwriting standards, broad indemnification agreements and collateral requirements, we are able to maintain significant ceded reinsurance business on a relatively small amount of capital compared to our peers.  For the year ended December 31, 2016, our gross leverage ratio was 14.7 to 1.  Our objective is to produce a total company gross leverage ratio of between 13 to 1 and 17 to 1.

Lender Services Insurance Ratios

Net loss ratio.  The net loss ratio is a measure of the underwriting profitability of our Lender Services segment.  Expressed as a percentage, this is the ratio of net losses and LAE incurred to net premiums earned. For the nine months ended September 30, 2017 and 2016, our net loss ratio was 48.0% and 44.1%, respectively.  This increase is primarily due to an increase in claim severity including an unusual number of high value claims.

Net expense ratio.  The net expense ratio is a component of our operational efficiency in administering our Lender Services segment.  Expressed as a percentage, this is the ratio of net expenses (commissions, taxes, licenses, and fees and general and administrative) to net premiums earned.  Our expense ratio is higher than that for most traditional insurance products due to the labor and systems intensive processes involved in monitoring the insurance statuses for the loan portfolios of our Lender Services clients.  For the nine months ended September 30, 2017 and 2016, our net expense ratio was 38.5% and 40.4%, respectively.

Net combined ratio.  The net combined ratio is a measure of the overall profitability of our Lender Services segment.  This is the sum of the net loss ratio and the net expense ratio. For the nine months ended September 30, 2017 and 2016, our net combined ratio was 86.5% and 84.5%, respectively.  Our objective is to price our products to achieve a net combined ratio between 85% to 90%.

Financial Ratios

Return on equity.  One of the key financial measures that we use to evaluate our operating performance is return on equity.  We calculate return on equity by dividing net income by the average GAAP equity.  Our return on equity at December 31, 2016 was 17.5%. Our overall financial objective is to produce a return on equity of at least 15% over the long-term.

Financial leverage ratio.  Our financial leverage ratio at September 30, 2017 was 13.1%, as compared to 14.8% at December 31, 2016.  Our objective is to maintain a financial leverage ratio in the range of 20% to 35% over the long-term.

Critical Accounting Estimates

Our consolidated financial statements include amounts that, either by their nature or due to the requirements of generally accepted accounting principles in the U.S. (“GAAP”), are determined using estimates and assumptions.  We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances.  While we believe that the amounts included in our consolidated financial statements reflect our best judgment, actual amounts could ultimately materially differ from those currently presented.  We believe the items that require the most subjective and complex estimates are: unpaid losses and LAE reserves, allowance for policy cancellations, unearned premium reserve, reinsurance recoverable, valuation of our investment portfolio, assessment of other-than-temporary impairments (“OTTI”) and minimum ceding fees.

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There were no significant changes to our critical accounting policies and estimation processes during the nine months ended September 30, 2017.  Our critical accounting policies and estimation processes are described in our audited consolidated financial statements and the related notes in the Company’s 2016 Annual Report on Form 10-K.

Consolidated Results of Operations	Three Months Ended				Nine Months Ended
	September 30,				September 30,
($ in thousands)	2017		2016		2017		2016
Revenues:
Premiums earned	$	35,499	$	33,700	$	105,941	$	94,293
Commission income		328		389		926		1,015
Ceding fees		21,697		19,263		60,340		52,424
Net investment income		2,314		2,001		6,753		6,141
Realized net investment gains (losses)		1,010		2,063		3,409		1,707
Other income		597		501		1,658		1,416
Total revenues		61,445		57,917		179,027		156,996
Expenses:
Losses and loss adjustment expenses		15,883		13,755		50,849		42,587
Commissions		1,064		1,408		4,341		4,235
Taxes, licenses, and fees		1,096		960		2,962		2,466
General and administrative		19,666		17,235		57,412		51,377
Interest expense		631		565		1,831		1,655
Total expenses		38,340		33,923		117,395		102,320
Income (loss) before income taxes		23,105		23,994		61,632		54,676
Income tax expense (benefit)		8,411		8,671		22,213		19,695
Net income (loss)	$	14,694	$	15,323	$	39,419	$	34,981

Consolidated Results of Operations for the Three Months Ended September 30, 2017 compared with the Three Months Ended September 30, 2016

Premiums earned.  Premiums earned increased by $1.8 million, or 5.3%, from $33.7 million for the three months ended September 30, 2016 to $35.5 million for the three months ended September 30, 2017.  Factors contributing to this increase are new sales, active account management and growth in the loan portfolios of existing accounts driven by continued high levels of automobile sales and higher average automobile loan balances.

Ceding fees.  Ceding fees increased by $2.4 million, or 12.6%, from $19.3 million for the three months ended September 30, 2016 to $21.7 million for the three months ended September 30, 2017, due to an increase in Program Services gross earned premium.  Program Services gross earned premiums increased from $311.5 million for the three months ended September 30, 2016 to $393.3 million for the three months ended September 30, 2017, resulting in an increase in premium-related ceding fees of $3.9 million from new and existing programs.  Capacity fees decreased $1.5 million for the three months ended September 30, 2017 compared to the three months ended September 30, 2016, due to a contractual decrease in minimum fees for 2017 compared to 2016.

Realized net investment gains.  Realized net investment gains decreased by $1.1 million from $2.1 million for the three months ended September 30, 2016 to $1.0 million for the three months ended September 30, 2017.  This decrease was partially the result of the liquidation of fixed maturity securities for the purchase of CNIC and gains on a sale of common stock in the three months ending September 30, 2016.

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Losses and loss adjustment expenses.  Losses and LAE increased by $2.1 million, or 15.5%, from $13.8 million for the three months ended September 30, 2016 to $15.9 million for the three months ended September 30, 2017, which was primarily the result of Lender Services increased exposure due to higher earned premiums and a slight increase in claim severity.  A strengthening economy, an aging automobile fleet, and easier access to credit have contributed to continued high levels of automobile sales, resulting in higher loan balances which are the bases upon which we pay claims.

General and administrative expense.  General and administrative expense increased by $2.5 million, or 14.1%, from $17.2 million for the three months ended September 30, 2016 to $19.7 million for the three months ended September 30, 2017, primarily due to investment in strategic growth and increased legal and consulting fees related to the Markel transaction.

Consolidated Results of Operations for the Nine Months Ended September 30, 2017 compared with the Nine Months Ended September 30, 2016

Premiums earned.  Premiums earned increased by $11.6 million, or 12.4%, from $94.3 million for the nine months ended September 30, 2016 to $105.9 million for the nine months ended September 30, 2017.  Factors contributing to this increase are new sales, active account management and growth in the loan portfolios of existing accounts driven by continued high levels of automobile sales and higher average automobile loan balances.

Ceding fees.  Ceding fees increased by $7.9 million, or 15.1%, from $52.4 million for the nine months ended September 30, 2016 to $60.3 million for the nine months ended September 30, 2017, due to an increase in Program Services gross earned premium.  Program Services gross earned premiums increased from $872.1 million for the nine months ended September 30, 2016 to $1.1 billion for the nine months ended September 30, 2017, resulting in an increase in premium-related ceding fees of $11.5 million from new and existing programs.  Capacity fees decreased $3.6 million for the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016, due to a contractual decrease in minimum fees for 2017 compared to 2016.

Realized net investment gains.  Realized net investment gains increased by $1.7 million from $1.7 million for the nine months ended September 30, 2016 to $3.4 million for the nine months ended September 30, 2017.  This increase was primarily due to an increase in the value of embedded derivatives on the Company’s convertible securities.

Losses and loss adjustment expenses.  Losses and LAE increased by $8.2 million, or 19.4%, from $42.6 million for the nine months ended September 30, 2016 to $50.8 million for the nine months ended September 30, 2017, which was primarily the result of Lender Services increased exposure due to higher earned premiums and an increase in claim severity including an unusual number of high value claims.  A strengthening economy, an aging automobile fleet, and easier access to credit have contributed to continued high levels of automobile sales, resulting in higher loan balances which are the bases upon which we pay claims.

General and administrative expense.  General and administrative expense increased by $6.0 million, or 11.7%, from $51.4 million for the nine months ended September 30, 2016 to $57.4 million for the nine months ended September 30, 2017, primarily due to investment in strategic growth and increased legal and consulting fees.

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Program Services Segment - Results of Operations

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
($ in thousands)	2017		2016		2017		2016
Revenues:
Premiums earned	$	—	$	3	$	—	$	3
Ceding fees		21,697		19,263		60,340		52,424
Total revenues		21,697		19,266		60,340		52,427
Expenses:
Losses and loss adjustment expenses		187		96		17		1,001
Commissions		4		2		8		5
Taxes, licenses, and fees		17		2		62		13
General and administrative		3,794		3,681		12,290		10,800
Total expenses		4,002		3,781		12,377		11,819
Income (loss) before income taxes	$	17,695	$	15,485	$	47,963	$	40,608
Gross premiums written	$	426,098	$	350,541	$	1,253,939	$	957,962
Gross premiums earned	$	393,303	$	311,463	$	1,110,189	$	872,090

Program Services Segment Results of Operations for the Three Months Ended September 30, 2017 compared with the Three Months Ended September 30, 2016

Ceding fees.  Ceding fees increased by $2.4 million, or 12.6%, from $19.3 million for the three months ended September 30, 2016 to $21.7 million for the three months ended September 30, 2017, due to an increase in Program Services gross earned premium.  Program Services gross earned premiums increased from $311.5 million for the three months ended September 30, 2016 to $393.3 million for the three months ended September 30, 2017, resulting in an increase in premium-related ceding fees of $3.9 million from new and existing programs.  Capacity fees decreased $1.5 million for the three months ended September 30, 2017 compared to the three months ended September 30, 2016, due to a contractual decrease in minimum fees for 2017 compared to 2016.

Program Services Segment Results of Operations for the Nine Months Ended September 30, 2017 compared with the Nine Months Ended September 30, 2016

Ceding fees.  Ceding fees increased by $7.9 million, or 15.1%, from $52.4 million for the nine months ended September 30, 2016 to $60.3 million for the nine months ended September 30, 2017, due to an increase in Program Services gross earned premium.  Program Services gross earned premiums increased from $872.1 million for the nine months ended September 30, 2016 to $1.1 billion for the nine months ended September 30, 2017, resulting in an increase in premium-related ceding fees of $11.5 million from new and existing programs.  Capacity fees decreased $3.6 million for the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016, due to a contractual decrease in minimum fees for 2017 compared to 2016.

Losses and loss adjustment expenses.  Losses and loss adjustment expenses incurred in the run-off of the retained business decreased by $1.0 million compared to the nine months ended September 30, 2016.  The decrease is due to changes in the ultimate expected reserve development between periods on the run-off of the retained business.

General and administrative expense.  General and administrative expense increased by $1.5 million, or 13.8%, from $10.8 million for the nine months ended September 30, 2016 to $12.3 million for the nine months ended September 30, 2017.  The increase was primarily due to investment in strategic growth.

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Lender Services Segment — Results of Operations

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
($ in thousands)	2017			2016			2017			2016
Revenues:
Premiums earned	$	35,499		$	33,697		$	105,941		$	94,290
Commission income		328			389			926			1,015
Other income		554			491			1,627			1,410
Total revenues		36,381			34,577			108,494			96,715
Expenses:
Losses and loss adjustment expenses		15,696			13,659			50,832			41,586
Commissions		1,060			1,406			4,333			4,230
Taxes, licenses, and fees		1,079			958			2,900			2,453
General and administrative		10,878			10,262			33,577			31,397
Total expenses		28,713			26,285			91,642			79,666
Income (loss) before income taxes	$	7,668		$	8,292		$	16,852		$	17,049
Net loss ratio		44.2	%		40.5	%		48.0	%		44.1	%
Net expense ratio		36.7	%		37.5	%		38.5	%		40.4	%
Net combined ratio		80.9	%		78.0	%		86.5	%		84.5	%
Gross premiums written	$	52,947		$	45,746		$	134,766		$	114,688
Net premiums written	$	42,469		$	37,517		$	109,093		$	94,433

Lender Services Segment Results of Operations for the Three Months Ended September 30, 2017 compared with the Three Months Ended September 30, 2016

Premiums earned.  Premiums earned increased by $1.8 million, or 5.3%, from $33.7 million for the three months ended September 30, 2016 to $35.5 million for the three months ended September 30, 2017.  Factors contributing to this increase are new sales, active account management and growth in the loan portfolios of existing accounts driven by continued high levels of automobile sales and higher average automobile loan balances.

Losses and loss adjustment expenses.  Losses and LAE increased by $2.0 million, or 14.9%, from $13.7 million for the three months ended September 30, 2016 to $15.7 million for the three months ended September 30, 2017, which was primarily the result of increased exposure due to higher earned premiums and a slight increase in claim severity.  A strengthening economy, an aging automobile fleet, and easier access to credit have contributed to continued high levels of automobile sales, resulting in higher loan balances which are the bases upon which we pay claims.

Lender Services Segment Results of Operations for the Nine Months Ended September 30, 2017 compared with the Nine Months Ended September 30, 2016

Premiums earned.  Premiums earned increased by $11.6 million, or 12.4%, from $94.3 million for the nine months ended September 30, 2016 to $105.9 million for the nine months ended September 30, 2017.  Factors contributing to this increase are new sales, active account management and growth in the loan portfolios of existing accounts driven by continued high levels of automobile sales and higher average automobile loan balances.

Losses and loss adjustment expenses.  Losses and LAE increased by $9.2 million, or 22.2%, from $41.6 million for the nine months ended September 30, 2016 to $50.8 million for the nine months ended September 30, 2017, which was primarily the result of Lender Services increased exposure due to higher earned premiums and an increase in claim severity including an unusual number of high value claims.  A strengthening economy, an aging automobile fleet, and

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easier access to credit have contributed to continued high levels of automobile sales, resulting in higher loan balances which are the bases upon which we pay claims.

General and administrative expense.  General and administrative expense increased by $2.2 million, or 6.9%, from $31.4 million for the nine months ended September 30, 2016 to $33.6 million for the nine months ended September 30, 2017, primarily due to investment in strategic growth and increased consulting fees.

Corporate Segment — Results of Operations

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
($ in thousands)	2017		2016		2017		2016
Revenues:
Net investment income	$	2,314	$	2,001	$	6,753	$	6,141
Realized net investment gains (losses)		1,010		2,063		3,409		1,707
Other income		43		10		31		6
Total revenues		3,367		4,074		10,193		7,854
Expenses:
General and administrative		4,994		3,292		11,545		9,180
Interest expense		631		565		1,831		1,655
Total expenses		5,625		3,857		13,376		10,835
Income (loss) before income taxes		(2,258)		217		(3,183)		(2,981)
Income tax expense (benefit)		8,411		8,671		22,213		19,695
Net income (loss)	$	(10,669)	$	(8,454)	$	(25,396)	$	(22,676)

Corporate Segment Results of Operations for the Three Months Ended September 30, 2017 compared with the Three Months Ended September 30, 2016

Realized net investment gains.  Realized net investment gains decreased by $1.1 million from $2.1 million for the three months ended September 30, 2016 to $1.0 million for the three months ended September 30, 2017.  This decrease was partially the result of the liquidation of fixed maturity securities for the purchase of CNIC and gains on a sale of common stock in the three months ending September 30, 2016.

General and administrative expense.  General and administrative expense increased by $1.7 million, or 51.7%, from $3.3 million for the three months ended September 30, 2016 to $5.0 million for the three months ended September 30, 2017, primarily due to increased legal and consulting fees.

Corporate Segment Results of Operations for the Nine Months Ended September 30, 2017 compared with the Nine

Months Ended September 30, 2016

Realized net investment gains.  Realized net investment gains increased by $1.7 million from $1.7 million for the nine months ended September 30, 2016 to $3.4 million for the nine months ended September 30, 2017.  This increase was primarily due to an increase in the value of embedded derivatives on the Company’s convertible securities.

General and administrative expense.  General and administrative expense increased by $2.4 million, or 25.8%, from $9.2 million for the nine months ended September 30, 2016 to $11.5 million for the nine months ended September 30, 2017, primarily due to investment in strategic growth and increased legal and consulting fees.

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Investment Portfolio

Our investment strategy emphasizes, first, the preservation of capital and, second, the generation of an appropriate risk-adjusted return.  We seek to generate investment returns using investment guidelines that stress prudent allocation among cash and cash equivalents, fixed-maturity securities and, to a lesser extent, equity securities.  Cash and cash equivalents include cash on deposit and short-term money market funds.  As of September 30, 2017, the tax adjusted yield on our fixed maturity and equity securities was 2.7%.  Convertible securities represent 12.5% of the portfolio at September 30, 2017, compared to 13.9% at December 31, 2016.  The average duration, excluding convertible securities, was 4 years and included obligations of the U.S. Treasury or U.S. government agencies, obligations of U.S. and Canadian corporations, mortgages guaranteed by the Federal National Mortgage Association, the Government National Mortgage Association, the Federal Home Loan Mortgage Corporation, Federal Farm Credit entities, and asset-backed securities and commercial mortgage obligations.  Our equity securities include preferred stock and common stock of U.S. corporations.  Our investment portfolio is managed by Asset Allocation & Management Company, LLC and AAM Advisors, Inc. (collectively, “AAM”).  We pay AAM an investment management fee based on the market value of assets under management.

For each period specified below, the cost, fair value, and gross unrealized gains and losses on available-for-sale securities were as follows:

	Cost or		Gross		Gross
September 30, 2017	Amortized		Unrealized		Unrealized		Fair
($ in thousands)	Cost		Gains		Losses		Value
Total fixed-maturity securities	$	400,885	$	8,552	$	(2,760)	$	406,677
Total equity securities		2,039		252		(175)		2,116
Total investments	$	402,924	$	8,804	$	(2,935)	$	408,793
	Cost or		Gross		Gross
December 31, 2016	Amortized		Unrealized		Unrealized		Fair
($ in thousands)	Cost		Gains		Losses		Value
Total fixed-maturity securities	$	329,994	$	5,717	$	(3,604)	$	332,107
Total equity securities		3,271		304		(351)		3,224
Total investments	$	333,265	$	6,021	$	(3,955)	$	335,331

The table below summarizes the credit quality of our fixed-maturity securities as of September 30, 2017, as rated by nationally recognized securities rating organizations.

					Percentage of
	Amortized		Fair		Fixed-Maturity
($ in thousands)	Cost		Value		Securities
U.S. Treasury	$	33,196	$	33,176		8.16%
AAA		103,904		105,234		25.88%
AA, AA+, AA-		117,591		118,317		29.09%
A, A+, A-		61,653		63,209		15.54%
BBB, BBB+, BBB-		66,428		67,643		16.63%
BB+ and lower		18,113		19,098		4.70%
Total	$	400,885	$	406,677		100.00%

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The amortized cost and fair value of available-for-sale debt securities held as of September 30, 2017, by contractual maturity, are shown in the table below.  Actual maturities may differ from contractual maturities because some borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	As of September 30, 2017
($ in thousands)	Amortized Cost		Fair Value
Due in one year or less	$	16,126	$	16,471
Due after one year through five years		136,335		138,915
Due after five years through ten years		115,806		117,204
Due after ten years		17,311		18,460
Residential mortgage-backed securities		60,514		60,682
Commercial mortgage-backed securities		54,793		54,945
	$	400,885	$	406,677

The tables below summarize the gross unrealized losses of fixed-maturity and preferred securities by the length of time the security had continuously been in an unrealized loss position for each year or shorter period specified below:

	Less than 12 Months				12 Months or More				Total
September 30, 2017	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
($ in thousands)	Value		Losses		Value		Losses		Value		Losses
Total fixed-maturity securities	$	134,785	$	(1,490)	$	13,961	$	(1,270)	$	148,746	$	(2,760)
Total equity securities		376		(26)		122		(149)		498		(175)
Total investments	$	135,161	$	(1,516)	$	14,083	$	(1,419)	$	149,244	$	(2,935)
	Less than 12 Months				12 Months or More				Total
December 31, 2016	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
($ in thousands)	Value		Losses		Value		Losses		Value		Losses
Total fixed-maturity securities	$	145,083	$	(2,771)	$	7,030	$	(833)	$	152,113	$	(3,604)
Total equity securities		573		(313)		42		(38)		615		(351)
Total investments	$	145,656	$	(3,084)	$	7,072	$	(871)	$	152,728	$	(3,955)

There were 242 and 270 securities at September 30, 2017 and December 31, 2016, respectively, that account for the gross unrealized loss, none of which we deemed to be other-than-temporarily impaired.  Management believes that the temporary impairments are primarily the result of a combination of widening credit spreads and higher rates, and that despite the wider credit spreads and higher underlying Treasury rates, the securities are only temporarily impaired due to the strength of the issuing companies’ balance sheets, as well as their available liquidity options.  For structured securities, future cash flow projections were used to determine potential impairment.  For those securities where cash flow projections showed less than 100% principal recovery, a net present value test was done to determine any credit related losses. We do not intend to sell or believe we will be required to sell any of our temporarily-impaired fixed maturities before recovery of their amortized cost basis.  Management has the intent and ability to hold the equity securities in an unrealized loss position until the recovery of their fair value.  Therefore, Management does not consider these investments to be other-than-temporarily impaired.

We are required to maintain deposits in various states where the insurance subsidiaries are licensed to operate.  These deposits are fixed maturity securities at fair values totaling $80.3 million and $77.0 million at September 30, 2017 and December 31, 2016, respectively.  The increase in the amounts on deposit at September 30, 2017 is due to an increase in the required deposits for workers’ compensation business and required deposits related to the acquisition of ISIC.

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Fair value of financial instruments.  Accounting Standards Codification 820, “Fair Value Measurements”, provides a definition of fair value, establishes a framework for measuring fair value, and requires expanded disclosures about fair value measurements.  The standard applies when GAAP requires or allows assets or liabilities to be measured at fair value; therefore, it does not expand the use of fair value in any new circumstance.  Investments measured at fair value on a recurring basis for the periods specified below:

	As of September 30, 2017
($ in thousands)	Level 1		Level 2		Level 3		Total
Fixed-maturity securities	$	—	$	406,677	$	—	$	406,677
Equity securities		6		2,110		—		2,116
Total investments	$	6	$	408,787	$	—	$	408,793
	December 31, 2016
($ in thousands)	Level 1		Level 2		Level 3		Total
Fixed-maturity securities	$	—	$	332,107	$	—	$	332,107
Equity securities		—		3,224		—		3,224
Total investments	$	—	$	335,331	$	—	$	335,331

Liquidity

We are organized as a holding company with five domestic insurance company subsidiaries, as well as a wholly-owned subsidiary that operates in an agency capacity.  Our principal sources of operating funds are premiums, ceding fees, investment income and proceeds from sales and maturities of investments.  Our primary uses of operating funds include payments of claims and operating expenses.  We pay claims using cash flow from operations and invest our excess cash primarily in fixed-income securities.  We expect that projected cash flows from operations and our revolving credit facility will provide us with sufficient liquidity to fund our anticipated growth and to pay claims and operating expenses, interest on debt facilities and other holding company expenses for the foreseeable future.  However, if our growth attributable to potential acquisitions, internally generated growth, or a combination of these factors, exceeds our expectations, we may have to raise additional capital in the near term.  If we cannot obtain adequate capital on favorable terms or at all, we may be unable to support future growth or operating requirements and, as a result, our business, financial condition and results of operations could be adversely affected.  We may generate liquidity through the issuance of debt or equity securities or financing through borrowings under credit facilities, or a combination thereof.

Our insurance subsidiaries are subject to statutory and regulatory restrictions imposed on insurance companies by their states of domicile which limit the amount of cash dividends or distributions that they may pay to us unless special permission is received from the insurance regulator of the relevant domiciliary state.  The aggregate limit imposed by the various domiciliary states of our insurance subsidiaries was approximately $26.9 million and $23.0 million as of December 31, 2016 and 2015, respectively.  In addition, we are able to generate substantial cash flow outside of our regulated insurance company subsidiaries through intercompany agency and management agreements between our insurance subsidiaries and our agency.

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The following table is a summary of our consolidated statements of cash flows:

	Nine Months Ended
	September 30,
($ in thousands)	2017		2016
Cash and cash equivalents provided by (used in):
Operating activities	$	52,690	$	48,938
Investing activities		(72,850)		(5,921)
Financing activities		(7,535)		(15,025)
Net change in cash and equivalents	$	(27,695)	$	27,992

Comparison of Nine Months Ended September 30, 2017 and 2016

Net cash used in investing activities increased $66.9 million for the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016, primarily due to investing earnings in fixed maturity securities.  The increase also included $32.0 million related to the acquisition of ISIC, net of cash obtained.

Net cash used in financing activities decreased $7.5 million for the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016, primarily due to 2016 including payments for settlement of stock repurchases.

Other Material Changes in Financial Position

	September 30,		December 31,
($ in thousands)	2017		2016
Selected Assets:
Accounts receivable from agents, net	$	145,867	$	35,964
Reinsurance recoverable on paid losses		1,740		1,430
Reinsurance recoverables		2,871,500		2,342,864
Goodwill and intangible assets, net		14,364		12,588
Selected Liabilities:
Unpaid losses and loss adjustment expenses	$	2,087,941	$	1,703,706
Unearned premiums		828,583		680,691
Allowance for policy cancellations		68,568		66,418
Deferred ceding fees		39,639		32,226
Accounts payable to insurance companies		118,791		14,871
Other liabilities		63,454		36,023

Accounts receivable from agents, net and Accounts payable to insurance companies.    Accounts receivable from agents includes premiums receivable, ceding fees receivable and premium taxes receivable, the majority of which relates to our Program Services segment.  The net receivable increased $109.9 million compared to December 31, 2016.  The Company recently entered into a limited number of large programs, in which certain qualifying criteria were met, where the Company retains the risk associated with the collection and payment of premiums.  As a result, the related premiums receivable and payable are reflected in our balance sheet.  The Accounts payable to insurance companies balance increased $103.9 million and is related to premiums payable on these same contracts.  

Goodwill and intangible assets, net.    As of September 30, 2017, goodwill and intangible assets increased $1.8 million compared to December 31, 2016 primarily due to an increase in indefinite-lived intangible assets of $2.3 million related to the ISIC acquisition.

Reinsurance recoverables, unpaid losses and loss adjustment expenses and unearned premiums.    As of September 30, 2017, we held $2.6 billion in collateral securing $1.8 billion in reinsurance recoverables.  The remaining unsecured

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reinsurance recoverables of $1.0 billion are ceded to highly rated, well capitalized reinsurers.  During the nine months ended September 30, 2017, reinsurance recoverables increased $528.6 million from December 31, 2016, which was primarily a result of the increase in gross premiums written for Program Services business due to the addition of new programs and expansion of existing programs.  These factors also caused an increase in the corresponding unearned premiums and the unpaid losses and loss adjustment expenses of $147.9 million and $384.2 million, respectively.

Allowance for policy cancellations.  As of September 30, 2017, the allowance for policy cancellations increased by $2.2 million from December 31, 2016, primarily due to the increase in the current quarter volume when compared to the last three months of 2016.  The third and fourth quarters have generated the greatest amount of written premium resulting in an increase in the allowance.  On a quarterly basis, we review our estimates for allowance for policy cancellations to determine whether further adjustments are appropriate.  Any resulting adjustments are included in the current period’s operating results.  The allowance for policy cancellations for the nine months ended September 30, 2017 and 2016 included upward revisions to prior year estimates of $0.4 million and $1.5 million, respectively.  Because of the interplay between the allowance for policy cancellations and the related unearned premium reserve, changes in the allowance for policy cancellations are partially offset by related changes in the unearned premium reserve and amounts ceded to reinsurers.  After taking into account the associated changes in unearned premium and amounts ceded to reinsurers, the net impact to the balance sheet and the corresponding reduction in net income from the revised estimates for the nine months ended September 30, 2017 and 2016 was approximately $0.3 million and $0.7 million, respectively.

Capital Resources

Between 2002 and 2004, the Company, through its subsidiary T.B.A. Insurance Group, Ltd. (“TBA”), formed three business trusts (the “Trusts”) for the sole purpose of issuing, in private placement transactions $44.5 million of trust preferred securities (“TPS”).  In turn, the Trusts used the proceeds thereof, together with the equity proceeds received from TBA upon their initial formation, to purchase variable-rate subordinated debentures (“TPS Debentures”) issued by TBA.  All voting securities of the Trusts are owned by TBA, and the TPS debentures are the sole assets of the Trusts.  The Trusts meet the obligations of the TPS with the interest and principal paid on the TPS debentures.  These debentures’ interest rates range from 3.80% to 4.10% plus the three-month LIBOR.  All of the debentures mature between 2032 and 2034.

On March 31, 2016, TBA entered into a loan agreement, which provides for a secured revolving credit facility in an aggregate principal amount of $15 million.  The credit agreement matures on April 30, 2018.  Under the credit agreement, TBA may request advances up to the aggregate amount of the unused commitment under the credit facility, on a revolving basis, prior to the maturity of the credit agreement.  Borrowings under the credit agreement will bear interest at a variable rate equal to LIBOR plus 1.85% per annum; provided, however, that LIBOR shall be subject to a floor of 0.15%.  TBA shall also pay a commitment fee on the daily average unused commitment amount for the period running from the closing date to the maturity date at a rate of 0.125% per annum.  The credit agreement contains customary representations, warranties, covenants, and events of default, as well as a financial covenant requiring TBA and the Company to maintain a consolidated tangible net worth of at least $150 million.

Item 3.Quantitative and Qualitative Disclosures About Market Risk

Liquidity Risk

Liquidity risk represents our potential inability to meet all payment obligations when they become due.  We maintain sufficient cash and marketable securities to fund claim payments and operations.

Credit Risk

We are exposed to credit risk from potential losses arising principally from the financial condition of our third party reinsurers and certain GAs, and also from potential losses in our investment portfolio.  Although our third party reinsurers are obligated to reimburse us to the extent we cede risk to them, we are ultimately liable to our policyholders on all risks we have ceded.  As a result, reinsurance contracts do not limit our ultimate obligations to pay claims covered under the insurance policies we issue and we might not collect amounts recoverable from our reinsurers.  We generally

36

address this credit risk by either (1) selecting reinsurers that have an A.M. Best rating of “A-” (Excellent) or better, have $300 million in equity and/or capital and surplus and are a Texas or Delaware authorized reinsurer at the time we enter into the agreement, or (2) requiring that the reinsurer post substantial collateral to secure the reinsured risks.  Security can take the form of collateral (in the form of security posted with a trustee pursuant to a related agreement, or evergreen letter of credit), or guaranty by a related third party that we believe has the ability to pay.  The security amount is a function of the policyholder liabilities (unearned premiums, losses and LAE reserves) or other amounts that are more representative of the amounts at risk.  Excess security is required when a reinsurer does not meet the above financial requirements to provide a “cushion” for inadequate estimates of policyholder liabilities.  Unless there is some mitigating factor, we control the ability to set policyholder liability amounts for security purposes.

Security is also contractually required if a reinsurer falls below the benchmark rating during the term of a reinsurance agreement.  Existing security may be increased if a reinsurer is downgraded during the term of a reinsurance agreement or experiences a significant loss in policyholder equity and/or capital and surplus.

Collateral levels are reviewed weekly on each reinsurer on which security is required.  Collateral calculations are adjusted as monthly activity reports are received on individual programs and collateral account balance information is available.  Collateral is generally obtained a quarter in advance at the end of each calendar quarter.

We recently entered into in a limited number of large programs where we are responsible to certain reinsurers for the collection and payment of premiums.  In these instances, we are exposed to credit risk should the general agent be unable to meet their contractual obligations to the reinsurers.  We accept this risk only for clients meeting certain qualifying criteria.  We mitigate this risk by monitoring balances due from the general agent, audits of the general agent, and actuarial analyses.

We also evaluate the credit risk of our investment portfolio.  The primary measure we utilize to mitigate credit risk (the risk of principal default on the securities we invested in) involves the credit quality of our portfolio.  Approximately 63% of our portfolio is rated AA- or higher (rated by nationally recognized securities rating organizations), which is consistent with the guidelines provided to our asset managers.  Additionally, our Investment Committee reviews the portfolio on a quarterly basis and discusses any securities which have been downgraded in the previous quarter.

Market Risk

The risk of underperformance in the market is addressed by having a quality asset manager administering our portfolio.  Additionally, our portfolio is diversified to eliminate exposure to any one particular segment.  Finally, as the bulk of our assets support either our surplus or short tailed lines of business, investment performance is a relatively small portion of our profits relative to other property and casualty companies.

Our investment policy is reviewed periodically and updated to meet current needs.  However, the primary goal and philosophy of the policy is to be conservative in nature to provide preservation of principal and provide necessary liquidity.

Interest Rate Risk

This is a two-fold risk involving loss of market value due to a rising interest rate environment coupled with a need to liquidate those securities to provide liquidity for operations.  Our exposure to extreme shifts in interest rates is mitigated to some extent by selecting a duration target for the portfolio which is relatively short (i.e., approximately four years).  The exposure to actually selling underwater securities to gain liquidity is managed by maintaining a laddered portfolio whereby we have securities maturing over the next few years.  Further mitigation is provided by maintaining the convexity (i.e., how the duration of a bond changes as the interest rate changes) of the portfolio at relatively low levels.

We had fixed-maturity securities with a fair value of $406.7 million and an amortized cost of $400.9 million as of September 30, 2017 that are subject to interest rate risk.  Interest rate risk is the risk that we may incur losses due to adverse changes in interest rates.  Fluctuations in interest rates have a direct impact on the market valuation of our fixed-

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maturity securities.  In the management of this risk, the characteristics of duration, credit and variability of cash flows are critical elements.

The table below summarizes the interest rate risk associated with our fixed-maturity securities by illustrating the sensitivity of the fair value of our fixed-maturity securities as of September 30, 2017 to selected hypothetical changes in interest rates, and the associated impact on our shareholders’ equity.  We anticipate that we will continue to meet our obligations from operating cash flows.  We classify our fixed-maturity securities and equity securities as available-for-sale.  Temporary changes in the fair value of our fixed-maturity securities impact the carrying value of these securities and are reported in our shareholders’ equity as a component of other comprehensive income, net of deferred taxes.  The selected scenarios in the table below are not predictions of future events, but rather are intended to illustrate the effect such events may have on the fair value and carrying value of our fixed-maturity securities and on our shareholders’ equity, each as of September 30, 2017.

Hypothetical Change
in Interest Rates	Fair		Estimated Change in		Total
($ in thousands)	Value		Fair Value		Return %
300 basis point increase	$	358,403	$	(48,274)	-11.87	%
200 basis point increase		373,410		(33,267)	-8.18	%
100 basis point increase		389,611		(17,066)	-4.20	%
No change		406,677		—	—
100 basis point decrease		423,512		16,835	4.14	%
200 basis point decrease		440,186		33,509	8.24	%
300 basis point decrease		457,929		51,252	12.60	%

Changes in interest rates would affect the fair market value of our fixed-rate debt instruments but would not have an impact on our earnings or cash flow.  As of September 30, 2017, we had $44.5 million of debt instruments, gross of debt issuance costs.  A fluctuation of 100 basis points in interest on our variable-rate debt instruments, which are tied to LIBOR, would affect our earnings and cash flows by $0.4 million before income tax, on an annual basis, but would not affect the fair value of the variable-rate debt.

Item 4:Controls and Procedures

Under the supervision and with the participation of our Management, including our chief executive officer and chief financial officer, we have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report.  Based on that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report to provide reasonable assurance that information we are required to disclose in reports that are filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.  We note that the design of any system of controls is based in part upon assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving the stated goals under all potential future conditions.

There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) as of the end of the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II - OTHER INFORMATION

Item 1:Legal Proceedings

We are routinely involved in legal proceedings arising in the ordinary course of business, in particular in connection with claims adjudication with respect to our policies.  We believe that there is no individual case pending that is likely to have a material adverse effect on our financial condition or results of operations.

Item 1A:Risk Factors

The announcement and pendency of the merger among State National Companies, Inc., Markel Corporation and Markelverick Corporation could have an adverse effect on the Company’s stock price, business, financial condition, results of operations or business prospects.

The announcement and pendency of the merger could disrupt the Company’s businesses in the following ways, among others:

· employees may experience uncertainty regarding their future roles with the combined company, which might adversely affect the Company’s ability to retain, recruit and motivate key personnel;

· the attention of the Company’s management may be directed toward the completion of the merger and transaction-related considerations and may be diverted from the day-to-day business operations of the Company, and matters related to the merger may require commitments of time and resources that could otherwise have been devoted to other opportunities that might have been beneficial to the Company; and

· third parties with business relationships with the Company may seek to terminate and/or renegotiate their relationships with the Company as a result of the merger, whether pursuant to the terms of their existing agreements with the Company or otherwise.

The merger agreement also restricts the Company from engaging in certain actions and taking certain actions without Markel’s approval, which could prevent the Company from pursuing opportunities that may arise prior to the closing of the merger or termination of the merger agreement.

Any of these matters could adversely affect the Company’s business, financial condition, results of operations, prospects and stock price.

Failure to complete the merger could negatively affect the stock price and the future business and financial results of State National Companies, Inc.

If the merger is not completed, the ongoing business of the Company may be adversely affected and the Company will be subject to several risks, including the following:

· having to pay certain significant costs relating to the merger without receiving the benefits of the merger;

· the attention of management of the Company will have been diverted to the merger instead of the Company’s own operations and pursuit of other opportunities that could have been beneficial to the Company; and

· resulting negative customer perception could adversely affect the ability of the Company to compete for, or to win, new and renewal business in the marketplace.

Any of these matters could adversely affect the Company’s stock price and future business and financial results of the Company.

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State National Companies, Inc. will incur substantial transaction and merger-related costs in connection with the merger.

The Company expects to incur a number of substantial non-recurring transaction fees and other costs associated with the merger.  Additional costs are expected to be incurred in order to complete the merger. In the event the merger agreement is terminated, under certain circumstances the Company may be required to pay Markel a termination fee of approximately $27.6 million, and if the Company’s shareholders do not approve the merger, under certain circumstances the Company may need to pay Markel a termination fee of approximately $13.8 million.  The Company’s shareholders approved the merger on October 24, 2017.

Item 2:Unregistered Sales of Equity Securities and Use of Proceeds

On October 12, 2015, the Company announced a share repurchase program authorizing the repurchase up to $50 million in shares of the Company's common stock through December 31, 2016.  The repurchase program was extended through December 31, 2017.  Repurchases are made in accordance with the guidelines specified under Rule 10b-18 and may be made pursuant to Rule 10b5-1 under the Securities Exchange Act of 1934.  For the nine months ended September 30, 2017, the company has not made any repurchases.

Item 3:Defaults Upon Senior Securities

None.

Item 4:Mine Safety Disclosures

Not applicable.

Item 5:Other Information

None.

Item 6:Exhibits

The information required by this item is set forth on the exhibit index which follows the signature page of this report.

Available Information

Our company website address is www.statenational.com.  We use our website as a channel of distribution for important company information.  Important information, including press releases, investor presentations and financial information regarding our company, is routinely posted on and accessible on the Investor Relations subpage of our website, which is accessible by clicking on the tab labeled “Investor Relations” on our website home page.  We also use our website to expedite public access to time-critical information regarding our company in advance of or in lieu of distributing a press release or a filing with the Securities and Exchange Commission disclosing the same information.  Therefore, investors should look to the Investor Relations subpage of our website for important and time-critical information.  Visitors to our website can also register to receive automatic e-mail notifications alerting them when new information is made available on the Investor Relations subpage of our website.  In addition, we make available on the Investor Relations subpage of our website (under the link “Financial Information” and then “SEC Filings”), free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, ownership reports on Forms 3, 4 and 5 and any amendments to those reports as soon as practicable after we electronically file such reports with the Securities and Exchange Commission.  Further, copies of our Amended and Restated Certificate of Incorporation and Amended and Restated Bylaws, our Code of Business Conduct and Ethics and the charters for the Audit, Compensation and Nominating and Corporate Governance Committees of our Board of Directors are also available through the Investor Relations subpage of our website (under the link “Corporate Governance”).

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Additionally, the public may read and copy any of the materials we file with the Securities and Exchange Commission at the Securities and Exchange Commission’s Public Reference Room at 100 F Street, NE, Room 1580, Washington, D.C. 20549.  Information on the operation of the Public Reference Room may be obtained by calling the Securities and Exchange Commission at (800) SEC-0330.  Our electronically filed reports can also be obtained on the Securities and Exchange Commission’s internet site at http://www.sec.gov.

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INDEX TO EXHIBITS

Exhibit Number	Exhibit Description
10.1	Amendment number one to the Employment Agreement by and between T.B.A Insurance Group, LTD. and Mathew A. Freeman, dated October 13, 2017.
31.1	Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a)
31.2	Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a)
32.1	Certification of Periodic Financial Report Pursuant to 18 U.S.C. Section 1350 (furnished herewith)
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB	XBRL Taxonomy Extension Label Linkbase Document
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		STATE NATIONAL COMPANIES, INC.
Date:	November 8, 2017		/s/ Terry Ledbetter
			Terry Ledbetter
			Chief Executive Officer
Date:	November 8, 2017		/s/ David Hale
			David Hale
			Chief Operating Officer and Chief Financial Officer

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